Instead of Boosting the Economy, This Has Increased U.S. Debt

The Tax Breaks’ Biggest Achievement Is to Have Increased the Risk of U.S Debt

In a mere decade, Washington achieved what should have taken at least 80 years to achieve. The U.S. federal debt (U.S. debt, for short) increased by $11.0 trillion.

In 2009, after the sub-prime crisis began, U.S. debt was about $10.0 trillion, bank bailout and all. U.S. debt is now at $21.0 trillion and, as the voice in the James Bond movies says, “and counting.” It could offset any gains that the current economic recovery has generated.

Advertisement

As a percentage of gross domestic product (GDP), the current level of U.S. debt is about 106% of GDP. The only time it was higher was in 1946, right after World War 2. (Source: “United States Gross Federal Debt to GDP,” Trading Economics, last accessed October 23, 2018.)

The Defense Budget Is Nothing Compared to U.S. Private Debt

It makes President Donald Trump’s $716.0-billion defense budget look like a milk run at the corner store. The U.S. public has little chance to intervene, given that it has accumulated some $13.3 trillion in debt, almost 70% of which comes from housing mortgages.

Student loans contribute $1.5 trillion of that. Imagine what will happen when students discover the meaning of “real” interest rates. Most families won’t be able to cope with higher interest rates when their credit card bills arrive.

The level of credit card debt has bounced back to where it was in 2008. Is there any question, then, as to what the detonator of the next financial crisis could be?

Any one of the sources of private debt alone, from student debt to car loans and mortgages, could trigger another financial crisis. U.S. debt, in its public and private forms, has become the detonator.

It’s pointless to blame President Barack Obama. He had little choice but to agree to the rise in aggregate debt to help the U.S. economy recover after a period of almost zero growth in the wake of the sub-prime crash.

It wasn’t President Obama who approved the bailout of the banks to the tune of $1.3 trillion, by the time all was said and done. Though, he, like his predecessor G.W. Bush, would have had little choice but to approve massive liquidity—quantitative easing (QE)—to stimulate the economy.

QE Has Produced a Debt Hangover

Another definition for quantitative easing might simply be “delayed pain.”

The Fed’s low interest rates didn’t make the pain fly away. It merely transferred the pain to a box—let’s call it Pandora’s box—which will unleash all manner of monetary ills when the higher rates unlock it and slam it wide open.

Somehow, I picture the end of QE as Picasso’s “Guernica.” Or like that scene in Raiders of the Lost Ark. You know the one. Spoiler alert: In that situation, as in the coming one, it’s best not to look…

The stock market, where valuations have soared beyond reason, might cave under the pressure.

Just look at how some of the top emerging markets have already reacted to rising U.S. interest rates. Countries like Turkey, Argentina, or Indonesia have been forced to adopt austerity-like measures to sustain their currencies against the dollar.

Yet, if QE had not distorted the economy enough already, in came Donald Trump to the rescue with corporate tax cuts.

Some would add the increase in military spending to the mix. But what’s a few dozen billion dollars here and there?

The corporate tax cuts are more permanent and put more pressure on the U.S. debt situation.

The Treasury Department itself admitted that the national debt increased faster than anyone had expected. Then again, it should have been expected, given the reduction of corporate contributions from 35% to 21%.

Tax revenues are now at the lowest levels since the Commerce Department started collecting statistical data in the 1940s. Corporations are paying 33% less than in previous years, the lowest since WW2.

Yet, while statistics report higher average incomes and growth, the tax cuts have gone suspiciously more toward stock buybacks than the infrastructure spending President Trump had promised when he was a candidate.

The buybacks, meanwhile, have drugged—or tampered, if you prefer—analysts’ earnings expectations and the stock prices themselves. Earnings per share have benefited from the tax breaks, without any related productivity or value increase.

Corporations that have repatriated foreign earnings to exploit the dramatically lower taxes have not then reinvested the funds in research, development, or employment. Those should have been necessary conditions to take advantage of the tax breaks.

But they were not, and greed will do as greed does. Buybacks, however, were all the rage on Wall Street this season. And perhaps, if there’s a central theme to the 2017-2018 tax reform, it’s the buyback.

Share Buybacks Distort the Economy And the Markets

Yes, they have given a boost to the earnings per share of American companies, but share repurchases have had a vicious effect as they help increase earnings per share without necessarily generating value.

The tax cuts, therefore, have magnified the relative attractiveness of U.S. securities in the first half of 2018. The result of more investors has been the fueling of bubbles, which will explode more violently as interest rates increase.

The U.S. Treasury’s number suggest that the significant cut in fiscal revenue has made a huge contribution to the higher deficit. (Source: “United States Gross Federal Debt to GDP,” CNBC, October 16, 2018.)

It’s a wonder that the level of chronic U.S. national debt has not yet brought Wall Street to its knees. The U.S. has become more vulnerable to bond risk—that is, the 10-year Treasury risk.

No Wonder Trump Complained About the Fed

The Federal Reserve’s higher rates now pose an explosive risk. No wonder Trump was complaining about Fed Chair Powell’s suggestions that he would raise them again before the end of the year.

Higher geopolitical risks may not yet have pushed the gold price higher, but they have done a bang-up job to add volatility in the U.S. bond market. That’s why the 10-year Treasury bill went to a yield of 3.2% at the start of October.

At that rate, Treasurys become more appealing than the majority of stocks. And they don’t come with the risk of stocks. Of course, as an “October surprise” ahead of the midterm elections, Trump has hinted at the possibility of more tax cuts.

Governments, like corporations, tend to issue more bonds when debt builds. But if the rates are appealing to buyers, that puts even more pressure on the stock market.

Meanwhile, to make matters even more interesting, China has started to sell its own Treasuries. They probably come as a response to Trump’s trade tariffs.

Dear Reader : There is no magic formula to getting rich. Success in investment vehicles with the best prospects for price appreciation can only be achieved through proper and rigorous research and analysis. We are 100% independent in that we are not affiliated with any bank or brokerage house. Information contained herein, while believed to be correct, is not guaranteed as accurate. Warning: Investing often involves high risks and you can lose a lot of money. Please do not invest with money you cannot afford to lose. The opinions in this content are just that, opinions of the authors. We are a publishing company and the opinions, comments, stories, reports, advertisements and articles we publish are for informational and educational purposes only; nothing herein should be considered personalized investment advice. Before you make any investment, check with your investment professional (advisor). We urge our readers to review the financial statements and prospectus of any company they are interested in. We are not responsible for any damages or losses arising from the use of any information herein. Past performance is not a guarantee of future results. All registered trademarks are the property of their respective owners.